How Boeing, Toyota, Caterpillar, and other OEMs can double their current net profit by using smart contracts to become unmanned “virtual companies”, with or without cryptocurrency: Part 11

A Special Discussion on Foreign Currency Risk Hedging with FX Derivatives

As discussed in part 7, OEMs have heavily globalized their supplier ecosystems (in order to tap into cheap-labor markets). The cost savings may be tremendous, but this has also exposed OEMs to the volatilities and risks of local currencies.

“Currency risk is emerging as most crucial risk for all Original Equipment Manufacturer (OEM) and their Tier-1 and 2 vendors in recent days…Numerous companies increasingly engage in global activities which can be categorized as import, export, outsourcing, and setting up productions and sales bases abroad. Most of MNCs face gain or losses due to uncertainty in foreign exchange rates…The volatile nature of foreign exchange rate poses a great risk of sudden and drastic movements, which may cause significantly damaging financial losses from otherwise profitable transactions.”-Sanjay Tiwari, COO of Yaskawa India in OEM Update Magazine

Global Finance Magazine gives out annual Foreign Exchange Awards. Not surprisingly, OEMs are well-represented:

United Technologies-Best Corporation for Use of Currency Hedging (2018)

Toyota-Best Corporation for Use of Foreign Exchange Options (2018)

Airbus-Best Corporation for Use of Foreign Exchange Forwards (2017 and 2018)

Ford-FX Innovation North America Regional Award (2018)

Siemens-FX Management Western Europe Regional Award (2018)

General Electric-Best Corporation for Use of Currency Hedging (2017)

Financial tools for hedging foreign currency risk are collectively referred to as “forex derivatives”. Forwards contracts are the predominant instrument, though by no means the only one. Let’s dive into the example of Airbus. To quote their entry in the 2017 Foreign Exchange Awards:

“With an aircraft order book equal to eight times annual turnover, Airbus maintains a hedging portfolio of $100 billion. The European aerospace company has long struggled with a mismatch between its dollar-based revenues and its euro-denominated manufacturing costs. Airbus must cope as well with a time lag of about eight years between payment commitments and the actual receipt of cash for the products it sells. It typically implements FX forward contracts to lock in the rate at which future receivables are converted into euros. In the first nine months of 2016, Airbus added new hedge contracts of $15.3 billion, of which $14.4 billion were forwards.”

How could smart contracts help? Recall from part 6 that the smart contract will automatically hunt for cheaper and less risky suppliers on a 24/7 basis as part of its eternal quest to stay on the “cheapest low-risk path”. Also recall from part 7 that Airbus will source 40% of its components from outside the US and Western Europe by 2020. In addition to avoiding BCCs and LCCs with a high likelihood for political and/or economic volatility, the Airbus smart contract could be programmed to intentionally avoid BCCs and LCCs that are likely to be strong against the Euro in the next 8 years.

By optimizing millions of individual buying decisions with this criteria in mind, Airbus’ across-the-board foreign currency risk exposure will drop drastically. In time, the risk might be deemed so sufficiently low that the FX derivatives portfolio can be downsized and that money freed up for other activities.

Continue to part 12….